New Fund Peril: Juicy Five-Year Returns Since the Crisis

By Brendan Conway

We’re five years removed from the worst of the financial crisis. A few months from now, we’ll be five years from the market bottom. Keep that in mind when you see mutual-fund companies reporting eye-popping five-year returns.

“Everyone knows that performance, particularly short term, is a poor guide of future returns, but it’s really hard to ignore it,” says Morningstar associate director of fund analysis Daniel Culloton. When investors do eye performance, they should “look at the longest term possible and try to carve it up to show whether it’s been consistent.” Ideally, they’ll also note how a fund has fared in certain periods of stress and euphoria, as well as how it stacks up against a variety of benchmarks.

Most five-year returns tend to cover a full market cycle, but it pays to go back even further if you can. “When I start judging a fund, I default to the 10-year return of the longest tenured manager,” Culloton says. That last point is important, since a great track record may not matter if the manager behind those numbers is long gone.

Because trailing returns capture just one point in time, analysts and advisors recommend looking at returns on a rolling basis. “Throw out the high and the low, and look at the real score,” says [Independent Adviser for Vanguard Investors editor Daniel P.] Wiener, who looks at the best, worst, and average rolling returns for a fund over several time periods. “You want to make sure a fund didn’t get all of its long-term performance in just seven months.”

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